On June 23, 2020, the U.S. Department of Labor (DOL) announced a proposed rule that would provide guidance under the DOL’s investment duties regulation with respect to environmental, social and governance (ESG) investing, an approach in which pension plans that are subject to the Employee Retirement Income Security Act of 1974, as amended (ERISA), select investments through consideration of certain nonfinancial factors, including environmental, social and corporate governance-related factors.

Historically, plan fiduciaries have wrestled with the appropriateness of investing in ESG-focused vehicles in light of their fiduciary duties of prudence and loyalty under ERISA, and prior regulatory guidance has provided mixed messages regarding ESG investing. The proposed rule, however, would provide clear guidance that plan fiduciaries may not invest in an ESG-focused vehicle if such vehicle’s investment strategy subordinates financial return or creates increased risk for nonfinancial purposes.

The most significant additions to the DOL’s investment duties regulation are as follows:

  • According to the preamble, the proposed rule confirms the DOL’s long-held position that ERISA requires plan fiduciaries to select investments and investment strategies based solely on financial considerations relevant to the risk-adjusted economic value of a particular investment or investment strategy to ensure that fiduciaries are protecting the financial interests of plan participants and beneficiaries.
  • The proposed rule expressly clarifies that plan fiduciaries may never subordinate the interests of plan participants and beneficiaries in their retirement income to nonfinancial objectives.
  • The proposed rule adds a new provision requiring fiduciaries, when considering an investment or investment strategy, to compare against other available investments and investment strategies in order to fulfill their fiduciary duties of prudence and loyalty under ERISA.
  • The proposed rule acknowledges that ESG factors and similar considerations may constitute financial considerations, but only if they present economic risks or opportunities that qualified investment professionals would treat as material economic considerations under generally accepted investment theories. The proposed rule emphasizes that the weight given to such factors should reflect a prudent assessment of their potential impact on risk and return.
  • In the rare circumstances where a plan fiduciary determines alternative investments to be economically indistinguishable, and one of the investments is selected based on nonfinancial or ESG factors, the proposed rule adds new language requiring fiduciaries to document why the investments were determined to be indistinguishable and why the selected investment was chosen.
  • The proposed rule adds a new provision regarding the selection of designated investment alternatives for defined contribution 401(k) plans, reaffirming that a plan fiduciary’s duties of prudence and loyalty under ERISA apply to the selection of an investment fund as a designated investment alternative and describing the requirements for selecting investment alternatives that pursue ESG-oriented objectives in their investment mandates. The requirements include that (1) the fiduciary uses only objective risk-return criteria in selecting and monitoring all investment alternatives, (2) the fiduciary documents its selection and monitoring of investments in accordance with the investment duties regulation and (3) the ESG-oriented investment alternative is not added as, or as a component of, a qualified default investment alternative.

In connection with the proposed rule, the DOL has requested comments, which must be submitted on or before July 23, 2020.